Kathleen Nemeth - Juniper Networks, Inc. Rami Rahim - Juniper Networks, Inc. Ken Miller - Juniper Networks, Inc..

Jess Lubert - Wells Fargo Securities LLC Pierre C. Ferragu - Sanford C. Bernstein & Co. LLC Balaji Krishnamurthy - Goldman Sachs & Co. Tal Liani - Bank of America Merrill Lynch Simon M. Leopold - Raymond James & Associates, Inc. Dmitry G. Netis - William Blair & Co. LLC Daniel Gaide - Barclays Capital, Inc. James E. Faucette - Morgan Stanley & Co.

LLC Justin Wainwright - Citigroup Global Markets, Inc. (Broker) Tejas B. Venkatesh - UBS Securities LLC Vijay Bhagavath - Deutsche Bank Securities, Inc. Jayson A. Noland - Robert W. Baird & Co., Inc. (Broker) Mitch Steves - RBC Capital Markets LLC Erik L. Suppiger - JMP Securities LLC George C.

Notter - Jefferies LLC Rohit Chopra - The Buckingham Research Group, Inc..

Greetings, and welcome to the Juniper Networks Third Quarter Fiscal Year 2016 Financial Results Conference Call. At this time all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Ms.

Kathleen Nemeth. Thank you. You may begin..

Thank you, operator. Good afternoon, and welcome to our third quarter 2016 conference call. Joining me today are Rami Rahim, Chief Executive Officer; and Ken Miller, Chief Financial Officer.

Today's call contains forward-looking statements, including statements concerning Juniper's business, economic and market outlook, strategy, future financial condition and operating results, capital return program and overall future prospects. Actual results might differ materially from those projected in the forward-looking statements.

Additional information that could cause actual results to materially differ from those in these forward-looking statements are listed in our most recent 10-Q, the press release furnished with our 8-K today and in other documents that we file with the SEC from time-to-time. All statements made during this call are made only as of today.

Juniper undertakes no obligation to update the information in this conference call in the event facts or circumstances change after the date of the call. Our discussion of the financial results today will include non-GAAP results. Full GAAP to non-GAAP reconciliation information can be found on the Investor Relations section of our website.

For important commentary on why our management team considers non-GAAP information a useful view of the company's financial results, please consult the press release furnished with our 8-K filed with the SEC today. Please keep your questions to one per firm. With that, I will now hand the call over to Rami..

Thanks Kathleen, and good afternoon, everyone. We delivered another solid quarter with total revenue at $1.285 billion, stronger than the outlook we provided, and up sequentially across all technologies and geographies.

We again delivered strong profitability metrics sequentially, including strong operating income, operating margin and earnings per share. I'm pleased with our overall performance, particularly with our focus on execution, and we continue to take steps necessary to position the company for continued growth.

I've said before that I believe we have a great strategy in place to be a pure-play innovator in IP networking that is going to transform the economics of networking with leading scale, performance and automation.

As the world moves rapidly to the cloud, we believe that the market is shifting in our favor and will actually help us accelerate our strategy to power this cloud transformation. The investments we've made over the last few years have culminated in the strongest and most highly differentiated product portfolio in the history of this company.

We now have a set of new products across key technology areas that we expect will help us achieve our revenue potential for the second half of this year and beyond. If you look at the products we've recently introduced in the market, they were developed with a keen understanding of what cloud providers want and need.

In many cases, they were developed in partnership with our customers. One of the most important things that we must do as a company is to ensure that we help our customers succeed as they transition to the cloud. Now I'd like to summarize some highlights this quarter across Routing, Switching and Security.

We are pleased to see our Routing business continue to grow sequentially and year-over-year. While we are particularly pleased with growth in the cloud vertical, we saw our diversification strategy play out across telco and cable verticals in our product mix and across geographies.

Our PTX line had another record revenue quarter and along with our MX platform, they are proving be our customers' preferred choices for their core and Edge as they move faster to deployment with increasing confidence and appreciation of our technology differentiation.

I'm very pleased with our strong performance in Switching, where we saw continued growth in the data center and with cloud and content providers.

We've seen a lot of interest for our new QFX products from cloud providers as well as from large telcos, cable providers, large enterprises and federal governments who are demanding high capacity, high speed networking. For the Q3 period, total revenue for our QFX switch line grew at 50% year-over-year.

Our deliberate focus on the cloud opportunity has resulted in a fast-growing data center switching portfolio over the past three years, and I believe we now have a complete portfolio that is going to help us continue to grow our Switching business in the future. Security continues to be a business that is in transition for us.

We've made progress in certain areas, introducing new management software and enhancing the overall efficacy of our flagship SRX platform, which in fact has recently received third-party validation for excellent security efficacy in next-gen firewall testing.

Earlier this month, at our Annual Customer Event NXTWORK 2016, we announced critical enhancements to our Security portfolio, extending our software-defined secured network vision with advanced automated enforcement throughout the network.

These additions include Junos Space Security Director's Policy Enforcer, which delivered deeper network threat prevention down to the switch level. We also announced new mid-range firewalls, the SRX4100 and the SRX4200 that are optimized for hybrid clouds environment.

Looking ahead, our priority remains on innovation, execution and on improving our performance and operating efficiencies. At Investor Day earlier this year we stated we are constructive on 2016 growth for the full year. We remain constructive in the second half of 2016 and are pleased with the traction our new products are seeing with customers.

The market trends taking place in the industry play to our core competencies and provide growth opportunities for a challenger like Juniper. We believe we are well positioned to capitalize on them. I want to thank our customers, partners and shareholders for their continued confidence and support.

Finally, I want to extend a very big thank you to our employees, who each play a role in helping shape a stronger Juniper. With that said, I'll turn the call over to Ken, who will discuss results of the quarter in more detail..

Thank you Rami, and good afternoon, everyone. The results of the September quarter reflect solid sequential revenue and earnings growth. Our sequential revenue growth was balanced across all technologies, markets and geographies. And we are pleased with the momentum of our new products.

We saw continued data center strength, particularly with our QFX family of products, which grew 50% year-over-year. In reviewing our top 10 customers for the quarter, four were cloud or cable providers, four were telecoms and two were enterprises. Of these customers, two were located outside of the United States.

Our underlying demand metrics were healthy this quarter with product book-to-build greater than one and an increase in product deferred revenue up 24% year-over-year and 2% sequentially. In the quarter, we had cash flow from operations of $245 million, down $109 million sequentially primarily due to payments for incentive compensation.

During the quarter, we repurchased $112 million of shares and paid $38 million in dividends. As many of you know, we initiated a capital return program in early 2014.

Since the first quarter of 2014, inclusive of share repurchases and dividends, we have returned approximately $4.60 billion of capital to shareholders against our commitment to return $4.1 billion. And we reiterate our commitment to return approximately 50% of annual free cash flow inclusive of share repurchases and dividends beginning in 2017.

Non-GAAP gross margin was within our guided range for the quarter. Year-over-year, the decrease in product gross margin on a GAAP and non-GAAP basis was due to product mix and elevated pricing pressure, partially offset by improvements in our cost structure.

While the pricing environment is challenging, we remain focused on delivering innovation and continued improvements to our cost structure. In the quarter, non-GAAP operating expenses were $494 million, which was slightly below the low end of our guidance range. This is a result of our continued focus on prudent cost discipline.

Now moving onto Q4 outlook, which is detailed in our CFO commentary available on our website. We are focused on executing to our strategy and capitalizing on the momentum of our new products and expect continued strength with cloud providers and enterprise customers.

While we continue to see pricing pressure and product mix fluctuations, we remain focused on cost improvements. We expect gross margins to remain approximately at their Q3 levels in the near-term.

On a full year basis at the midpoint of our guidance, we expect revenue growth, which is consistent with our outlook from previous quarters, as well as earnings per share growth. We are focused on growth and continued earnings expansion and are confident in our strategy and long-term model.

I would like to thank our team for their continued dedication and commitment to Juniper's success. And with that, I'd like to open the call for questions..

Thank you. We will now be conducting a question-and-answer session. Our first question comes from Jess Lubert of Wells Fargo Securities..

Hi, guys. Thanks for taking my question, and congrats on a nice quarter. I want to squeeze two in. First, for Rami, it sounds like you saw really good traction for the QFX lineup.

I was hoping you could help us understand which of these models have been driving the strength, if there were any large deals here, or if it was more broad-based? And perhaps to what degree do you see this lineup competing for routing opportunities versus Jericho-based alternatives, and what are the implications of success in that application on your core routing business? How should we think about that? And then for Ken, I was hoping you could provide some additional color on the pricing environment.

Last quarter, you suggested we'd likely to see some gross margin improvement. As volumes picked up in Q4, we could potentially get back to the 64% levels over time. Now it sounds like you don't expect to see any improvement in Q4. So perhaps you can touch upon what's changed.

Is pricing pressure still concentrated in Europe? Is it more broad-based? To what extent we should be thinking about 63% as the new normal, or do you still think we can see some improvement next year? Thanks..

Okay. Jess, thanks for the question. Let me start with the switching question, and then I'll pass it over to Ken to talk about gross margins. So first, very pleased with the performance of our switching business in the Q3 timeframe.

In particular, what you're seeing is that the focus that we have on the data center and the cloud opportunity is really starting to pay off for us. And you can see that in the strength of the QFX portfolio all up.

As you know, the new products that we've introduced, the QFX10002, the QFX10008 and the upcoming QFX10016 are all intended to round out an end-to-end switching portfolio that make us competitive in far more switching opportunities than we've ever been historically. And that's exactly what we're seeing.

So what we're – we're now participating in proof of concepts, in RFPs, et cetera, that we quite frankly just never had access to historically. So the new products that we've introduced are they themselves starting to ramp as we expected in the second half.

But more importantly, they round out a portfolio in a way that gives us more competitiveness overall. And now add to that our Contrail Orchestration System, routing at the edge of the data center and security, and we really have a very compelling end-to-end cloud data center portfolio that we're I think leveraging very effectively.

On your question around Jericho and silicon, obviously a question that we get quite a lot. Every new product we develop, we do it with a keen eye on making sure that we choose the very best silicon for that product. We're not religious about what silicon that we choose, but I will say this.

Every decision we've made thus far in all products across routing and switching that we have developed has been absolutely the right one.

And that means in certain cases, we're going to use custom, in certain cases, we're going to use merchant, and that might change over time as we look out and we develop sort of the roadmaps across switching and routing in the future. But for now, rest assured, I feel very good about the decisions that we've made thus far in our silicon choices.

I think you had one more thing which is around routing. The data center problem is in fact a high performance networking problem that requires a robust routing stack. And that is one of the key differentiators of our QFX product line.

Ken?.

Great. So on the gross margin question, Jess, yeah, the Q2 results were in line with our expectations for the quarter. From a pricing perspective, we did talk about elevated pricing pressure that we experienced in Q2. For Q3, we saw that normalize a bit, so we didn't see the continuation of the elevated pressure.

We saw a little more normalization across quarter-on-quarter. Still a very competitive market though. I would definitely keep that in mind. A lot of factors go into our guidance for gross margin. Clearly, the macro environment, the competitive landscape, customer mix, product mix, and there's a fair amount of uncertainty in some of those dimensions.

So I think the prudent thing at this point, which is what we set into our guidance, is to assume 63% not only for Q4 but in the near term as we continue to work through the macro uncertainties and some of the other fluctuations in our gross margin.

We're very focused on continuing to deliver innovation and continuing to improve our cost structure, and we are driving towards our 64% long-term gross margin. But again, I think the prudent thing to do for the time being Q4 and the near term would be to assume 64%. I'm sorry, 63%..

Thanks guys..

Next..

Okay, and thank you. Before we continue with the Q&A, let's try to keep it to one question you guys, as much as you can. Thanks..

Our next question comes from Pierre Ferragu..

Hi, everybody. Thank you for take the question. I had like a very long list of questions. Now, I'll have to pick one. I'm sorry for that. Maybe I'll pick a fairly specific one, that's on your QFX product line. So my assumption is that (16:03) is a lot of your success with your cloud clients at the moment.

And my other assumption is that what you've been able to bring to the market in terms telemetry and the quality of your telemetry features have weighted a lot in your commercial success. And if I'm not mistaken, Arista, who is probably one of your main competitors in that segment, brought up new product line with improved telemetry offerings.

And so my question would be do you think the competitive landscape could evolve a bit in the coming two or three quarters with a competitor getting closer to you, at least on that dimension? And could that inflect a bit your commercial success there?.

Yeah. Thanks, Pierre, for the question. First, I think that the success that we've seen in the QFX all up is more broad based than just the large cloud providers. I think there are – it includes success in certain cloud providers, in the enterprise, in federal government and also in fact, in some teleco opportunities as well.

When I think about the competitiveness of our product portfolio in Switching, there are very different aspects of it. First is scale. And typically when people hear the word scale they think of the number of ports on a box. But it's actually more complicated than that.

It's also around the number of routes, number of hosts, number of IP addresses, what we call logical scale. And we've really pushed the envelope on the logical scale of our product that give us an edge compared to anything that's out there today. Then there's the robust routing capabilities.

We have full Junos IP stack on this thing, which makes it very suitable for high performance, high scale data center opportunities. Telemetry, you're absolutely right. The team has done a fantastic job of innovating in terms of new modern telemetry capabilities. Do I expect that the competitive landscape will evolve? Absolutely.

We innovate all the time with the assumption that our competitors are aggressive and they're moving fast, and that's why we just have to move faster. And I think we're doing that. I think the most important thing you need to understand as you look at the switching and the cloud opportunity, is that we're playing an offensive game.

We are out to take share in switching, in data center with a new end-to-end portfolio that is very competitive..

Thanks for that..

Our next question comings from Simona Jankowski of Goldman Sachs..

Hi. This is Balaji on behalf of Simona. I was wondering if you could touch on the geographical trends, especially with Europe? You had a few quarters of declines there on a one-on-one basis. Where do you see a turn in that market? Thanks..

Yeah, sure. Thanks for the question. Let me start, and maybe Ken has some more color to add. First, I think we saw good momentum up year-over-year, 5% in the Americas. We also saw sequential growth in the Americas as well. That was driven largely by cloud providers, by cable operators and also by large enterprises.

So we're very pleased with the performance there. EMEA sequentially was actually quite healthy, and it's driven – our business in EMEA is driven mostly by large telcos. Now, there's certainly some factors in EMEA that we're keeping a very close eye on.

Economic stability, Brexit, foreign exchange and so on, that give us some room or some cause to be a little bit concerned about it going forward. But so far, I would say just judging by the performance we've seen in Q3, things are looking pretty good. Last but not least, APAC continues to be a good growth engine for us.

I think the team there is executing really well with 18% year-over-year growth driven by a number of different verticals, cloud in particular. And we're even seeing good sequential growth in China with the partnerships that we've announced there and with our product portfolio that's actually working quite well for us over there.

Anything you want to add, Ken?.

No, I mean, I'd just reiterate. EMEA was the one geography that was down year-on-year, as you noted. I think it is a challenging marketplace there. There's a lot going on. We're clearly staying as close to the market situation as we can.

And I would say because of the macro uncertainties, it has a propensity to be a little more choppy than normal, right? We are pretty concentrated on telco, as Rami mentioned, so as the telcos go, as some of the big deployments happen, you might see revenue fluctuate a little more in that geography going forward as some of the others..

Great. Thank you..

Our next question comes from Tal Liani of Bank of America..

Hey, guys. I want to compare the opportunity in telcos versus cloud, and take a more maybe of a long-term view.

So if the pending in telcos, if it continues to decline, is your participation in the cloud opportunity big enough or large enough to offset this? And maybe you can talk about your participation among cloud providers, what kind of products and projects – conceptually, what kind of projects and products you're working on? Thanks..

Sure. Thanks for the question. I think that the cloud opportunity remains robust for the foreseeable future.

I mean, at the end of this year and I think into next year, large cloud providers and as well as the second tier cloud providers that are what we call Born in the Cloud, their business models evolved around the cloud opportunity, are essentially recognizing that their wide area networks and their data center networks are essential to delivering the kinds of experience that their customers demand.

And for that reason, I think spending there will be robust. Telco is a little bit of a different story, and I've been consistent in how I've talked about the telco opportunity over the last few quarters.

First, I think just judging by the conversations we have with our telco customers as well as their CapEx reports for the year and how much they've spent thus far, we do expect there to be some spending by telcos in the Q4 period.

Longer-term in telcos, all service providers – or many service providers are going through an architectural transformation. They're really thinking about how to leverage their networks as essentially a distributed cloud network.

And we are very pleased with how we're working very closely with our telco customers, who we obviously enjoy a very close working relationship with, to help them with that transformation.

And that speaks to our broad portfolio of switching, routing, security and very much around our cloud software, Contrail being a very powerful tool that we have today to engage very strategically with these architectural transformations that are happening at our telco customers.

Summing that all up, I think that for – because of this transformation that's happening, telcos we can expect will divert their focus to that transition and less on just building out their core or their Edge networks in the way that they have done in the past.

The most important thing is that we remain very engaged, very close with them in the transformation so that we can benefit from the new types of buildouts that they will be deploying. And I think that will start in the 2017 timeframe.

So they're going through this shift, and we just have to make sure that we stay very close and we capitalize on the solutions we're offering them to help them with the shift itself..

Thank you..

Your next question comes from Simon Leopold with Raymond James..

Great. Thank you very much for taking my question. A genuine clarification first, and then the question. You were kind enough to give us some detail on the Top 10 customers showing some good balance.

I wasn't quite sure where the cloud providers, the Googles, Amazons, Facebooks, whether you consider those service providers or enterprises in your discussion of customers. So just a clarification on that.

And then in terms of the trend, you've talked about the web scale cloud providers being a high teens percent of revenue in the last couple of quarters. Just wondering where you stand today with that group? And how you see that group as a percent of sales longer term as you look out into 2017? Thank you..

Yeah. So the clarification, so those customers you mentioned would be part of our cloud vertical, which roll up into the service provider market if you will. So just to clarify that. That's where they stand..

From a vertical perspective, we talked a bit about – Rami just talked about the cloud vertical and its robustness going forward. And just to remind folks what we talked about at Investor Day. We expect that to be double-digit growth over the next three-year period, 10% to 13% CAGR.

Right now, last year FY 2015, the cloud vertical represented about 19% of our total revenue. Clearly it's going be our fastest growing vertical over the next few years. So it will continue to take more percentage of our total revenue. And we expect it to get to approximately 24% by 2019. So it will be a bigger piece of our revenue going forward..

Thank you very much..

Sure..

Our next question comes from Dmitry Netis of William Blair..

Thank you very much for taking my question. I actually had kind of a follow-up to a previous question. And that is if I look at the commentary, you guys had mentioned QFX had done real well. Data center cloud had done real well.

But if I look at the relative stress and width quarter-over-quarter where the revenue came from, it came mostly from the routing side. And I think from the commentary where the cloud guys sit, they sit in the service provider I think what you said.

That vertical was actually down by about $35 million versus Enterprise that was up $58 million quarter-over-quarter.

So I'm just trying to reconcile the strength there, whether that's really the PTX or is something else? Can you help us reconcile the difference?.

Yeah. I'm not sure I'm following your math precisely, so I apologize for that. We could follow-up. But I would say that from a year-on-year perspective, Switching led by QFX was our strongest growing technology. Switching was up 10%. Routing was up 3%. In absolute dollars, Routing continues to be our largest technology.

So in absolute dollars, they're more similar in growth year-on-year. The sequential growth was predominantly routing in absolute dollars but again, pretty broad based and consistent across technologies. Routing was up 8%. Switching was up 6%, and Security was up 9%.

So I'm not sure I answered your question, but I'd be glad to follow up with you with more details..

Yeah. Thank you. I was referring on the sequential basis, strictly where the relative strength came from. And it seems it had come from routing. That's – and then the enterprise was also pretty strong relatively speaking from quarter-over-quarter. So that's why I was just trying to reconcile those two..

Yeah. No, so, you're right. Routing was up 8% quarter-on-quarter. Switching was up 6%. We did have a pretty strong switching quarter in Q2. And we have seen strength in Enterprise on a sequential basis since the Q1 lows, right? So we had a pretty strong Q2 sequentially and Q3 sequentially. However, Enterprise is still down slightly year-on-year.

So the macro and some of the transition impacts that really affected us in Q1 are starting to subside, and we're starting to return to growth on the Enterprise segment..

Can I just follow-up on one thing, the PTX side of things.

Can you give us a little – can you qualify what the revenue percent of total? Or percent of routing? Or what the growth in that segment was as you did for QFX, just so that we can calibrate around it?.

Yeah. I'm not going to break it out, but I will give you a qualitative view. The PTX did very well. It had a record quarter. When we developed and released the PTX into the market, we had a thesis around how telcos and cloud providers are going be thinking about the evolution of their wide area networks, the data center interconnect networks.

And while it has taken us some time to convince our customers and to help them in making the architectural transition towards those lean core networks or the super-core networks that we called them, what we're seeing right now is exactly what we had expected and hoped for, which is a real acceptance, and in fact, enthusiasm for these sorts of super core, lean-core architecture that are driving the PTX business.

So very pleased with the PTX growth thus far. We have a highly differentiated core product in the PTX after the introduction of the new line cards for that platform in the first half of this year. And I am bullish about the growth of the PTX going forward as well..

Thank you very much..

Your next question comes from Mark Moskowitz of Barclays..

Hey, guys. This is Dan Gaide on for Mark. Thanks for taking my question. We know that Juniper's having success with next-gen solutions like Contrail and with virtual routing and CPE deployments at both AT&T and Verizon, and that the goal you guys announced is for 45% of revenue to come from software and services in 2019.

Are you still tracking with these plans? And how have deployments changed versus when you – what you may have expected when you originally announced those plans?.

Yes. So you're absolutely right in that Contrail continues to see more and more interest, more and more adoption, especially with the open stack, but not exclusively the open stack community. And more and more, for example, customers are jumping on to the Kubernetes container-type of solutions, for which Contrail is also highly suited.

When we think about our software strategy, there are several different elements to it. There is the controller element, the software-defined-networking element, to which Contrail certainly belongs, but also other products like our NorthStar Wide Area SDN controller. There is the virtual network function and the solutions around them.

So the success that we've seen with the Cloud CPE Solution at AT&T, Verizon as well as other Tier 1 telcos is indicative of the kinds of investments that we're making today that we believe are going to pay off in the future, I think starting next year. And then last but not least, the third leg of the stool is around our disaggregation strategy.

Over time, we do believe that the way in which we sell the value of our switching, our security, and routing to an extent is going to be more commensurate with how we invest in these products, where the bulk of our investment is in fact in the software. And for that reason, over time, I think this is going be gradual.

It's not going to happen overnight, which is why we've given ourselves a few years get to our target. What you're e going to see, I think, our customers are going to buy the value in terms of software SKUs that are essentially decoupled from the hardware. It's still early days.

There is an entire industry that needs to sort of transform around that change in business model. But we're working towards that goal. We're working very aggressively towards it..

Thank you..

Thank you..

Our next question comes from James Faucette of Morgan Stanley..

Thanks very much for taking my question.

Rami, kind of a follow-up question to that is as carriers undertake this network transformation you're talking, how are you navigating change in partnerships, et cetera, to provide those carrier customers with the technology knowhow and ability to – or helping them with their transition from a services perspective? And I guess tied into that, just an OpEx question.

You've been running OpEx a little bit lower than your target, at least as a percent of revenue. Do you see room for further cuts in OpEx going forward? Thank you very much..

Yeah. Let me touch on the partnership question. I'm sure Ken would want to weigh in on the OpEx piece. So we see this in a number of different ways. Partners are extremely important for us in going after broader teleco opportunities.

And yes, when it comes to some of these new cloud architectures that telcos are adopting, there are elements of the solution that we count on partners for, in particular, for example, around the OSS/BSS, the integration into their existing OSS/BSS systems and so forth.

And here we've got fantastic partnerships with companies like NEC, IBM and Amdocs that essentially enables us to provide those end-to-end solutions.

Having said that, however, in every one of these large teleco transformations, we have a very direct interface to the customer, and in some cases we find that the way in which we need to grow our business, our relevance, is by taking the customer from an indirect relationship, fulfillment relationship to a direct one.

And we've done that gradually around the world on an as-needed basis. The bottom line is I feel very good about our ability today to take the innovation that we produce in-house and to combine it with that of partners and to reach our customers around the globe through the go-to market capabilities of our partners. On OpEx, I'll let Ken..

Sure. Sure. So I'm particularly proud of our OpEx results this quarter, $494 million. We came in below the low point of our guidance range. And that is with an Aurrion, which was an acquisition we closed during the quarter that wasn't factored into our guidance. So we did a great job controlling our costs this quarter.

And you can count on us to continuing to do that going forward, particularly in light of some of the macro challenges we're experiencing in the gross margin line as an example.

We're doing everything we can to make sure we maximize shareholder returns and shareholder value and really managing OpEx tightly, making sure we grow and expand our earnings as we move forward in these marketing conditions. So it's something you can count on us continuing to do as we move forward..

Thank you..

Our next question comes from Jim Suva of Citi..

Yes. Hi. This is Justin on for Jim. Thank you for taking the question. I was just wondering if you could comment on any update wins you had for Contrail? And also, if you could just maybe comment in terms of the demand and what the pipeline looks like? Thank you..

Sure. Let me start with the Contrail question. I think it's fair to say that the adoption rate of Contrail is tracking really well. We have at least a half a dozen new logos that we scored just in this last quarter. And these are meaningful, large either cloud providers or service providers, telcos.

We're seeing especially good strength with the telcos as they undertake this cloud transformation within their own networks. And I expect there to be more success going forward.

A really important element of the Contrail success that we're seeing is in each and every one of the – I'd say most of the deployments that we've had thus far, it has led to pull-through opportunities, where we can now bundle a portfolio of switching, routing, security into the Contrail solution that we're offering to our customers..

Yeah. The only thing I would add, Rami, is it also typically comes with some professional services engagement as well, which is very – becoming more and more strategic to our overall solution sale. And last but not least the Contrail revenue will be slower and gradual as it comes to the subscription nature of the revenue.

So, some of our deferred revenue growth is Contrail and some of our other software products..

Thank you..

Yes..

Our next question comes from Steve Milunovich of UBS..

Hi. This is Tejas on for Steve. When I look at sequential routing growth in 4Q over the last few years, it's been up in certain years and down in certain years.

But as we look into 4Q this year, is it fair to assume that it will grow similar to last year, given the CapEx trends you talked about earlier?.

Yeah. I would expect both in Q2 and Q3 of this year we saw sequential growth across all technologies. I believe we're going to have a similar result in Q4. I do think we'll see some growth across many of the new products and all three of the technologies, routing, switching and security..

Yeah. The only thing I'd add to that is the product lineup that we have in routing today across the MX and the PTX with new line cards, new software that we've introduced on both those platforms in the first half of the year have set us up for a very, very competitive overall product portfolio that is going help us to grow going forward.

So I just feel very good about the overall technology situation and our competitiveness of the company in routing..

Our next question....

Thanks for the question..

...comes from Vijay Bhagavath of Deutsche Bank..

Yeah. Thanks. Yeah. Hi, Rami.

I'd like to get your big picture views Rami, on how Juniper plans to drive new growth in optical and in security? For example, would you look to exit any current underperforming products and focus on new growth opportunities in security opticals such as data center optical interconnect, cloud based security as we saw, Akamai (38:57) seeing strength? I'd like to get your thoughts.

Thanks, Rami..

Hi, Vijay. Thanks for the question. So both key areas of focus for us, I think that the work that Juniper did a year-and-a-half, two years ago, in streamlining and refocusing the company is really paying off for us today. So I do think that we are focused on the right areas or the right opportunities.

And the growth potential in each of the areas that we're focusing on is definitely there. You touch on two of them. Optical is a really important part of our overall solution. We're not thinking about optical as a standalone business. I think there are enough standalone optical players in this world.

We think about optical as an element of a end-to-end solution with key emphasis on the metro and the data center interconnect markets. These are the opportunities that I think are ripe for disruption with a converged packet optical solution that's managed through really highly automated software.

And I think that's the key behind the acquisition that we made of BTI. We now have the technology. We have the capability. We have the talent to enable us to integrate and develop these solutions for the data center interconnect and the metro market. And then in security, we've said it in the opening remarks. It's a business in transition.

We continue to see the sequential momentum that we need to see in the business. We have undertaken at the beginning of this year some very large somewhat tricky product transitions where we're replacing older security products with newer ones. And we're seeing good ramp-up in growth in the newer technologies that we've introduced in the market.

So as I think about security, the opportunity is there. I think our vision of a software defined secure network is the right one. And we're hearing very good positive comments from our customers, our partners, as well as industry analysts. Our software efficacy is only getting better every quarter.

And it really comes down to that last critical piece of refreshing the older portfolio with a newer portfolio that gives us the ability to compete from an economic standpoint, a cost per bit per second of security.

The QFX4100 and QFX4200 products we just announced at our Annual Customer Event a few weeks ago and they will be making their way into the market very shortly, and that's an example of that refresh cycle that I'm talking about. And you talked about cloud-based security. I do think that that is a direction of travel for security in the future.

And this is why we're also investing in our virtual security products like the virtual SRX where we're seeing actually good momentum now offered off of the Amazon Web Services marketplace and as well as our ATP, our Advanced Threat Prevention, Sky ATP Service that's offered from the cloud.

So these are indicative of investments today that we think will pay off in the second horizon of security which is all around the cloud..

Perfect. Hey, thanks, Rami..

Thanks, Vijay..

Our next question comes from Jayson Noland of Robert W. Baird..

Okay. Great. Thank you. I wanted to ask on SD-WAN you're highlighting it on your website. And Rami, is this – is it fair to say that this could impact MPLS router business to the negative but you have an opportunity with CPE in the branch? Or how should we frame SD-WAN as it relates to Juniper? Thank you..

Yeah. So we do view SD-WAN as a really important opportunity for us. But to be clear, we actually think of the SD-WAN opportunity maybe a little bit differently than our peers in the industry. We think of SD-WAN as just one point solution of a broad set of solutions that are – that enterprise customers will want and desire from telcos in the future.

And so, when you look at our solution, it really is around an open platform that – the foundation of which is Contrail as an orchestration system and the NFX250 is essentially an open platform that sits at the customer prem. It can run a multitude of services, SD-WAN being one of them, security being a second one of them.

Load balancing capabilities being a third one, et cetera, et cetera. And we actually sort of define this vision a couple of years ago. And what we're seeing now from our customers is, a keen acceptance of this as being the true future that they want to go and to achieve. I think of this as highly complementary to our overall opportunity at Juniper.

Our existing physical box centric sort of CPE business is relatively small unlike many of our competitors and so we can play a much more disruptive game there.

And then to your question around does this have an impact on the MPLS-WAN space, if you will? I think a lot of these solutions will depend on a hybrid model where they will leverage the Internet for certain types of traffic as well as manage the MPLS for other types of traffic.

All up, I think if you integrate the whole opportunity, I think it's a net add for us..

Thank you..

Our next question comes from Mitch Steves of RBC Capital Markets..

Hey guys. Thanks for taking my question. So most of them have been asked, but I kind of wanted to return real quick to the gross margin piece. If I recall correctly, I believe last quarter, the June quarter, the routing segment was part of the reason why the gross margins were actually better, or a little bit better.

But now we're seeing a gross margin beat again. Or sorry, a routing beat again but the margins are going down.

So is it fair to say that maybe the QFX (45:13) lower margin than 63% to 64% range?.

No. I wouldn't jump to that conclusion. I would say gross margin there are many, many inputs into gross margin from obviously pricing being a large one and I already mentioned pricing was actually relatively stable. We didn't see much change quarter-on-quarter as it relates to pricing.

But product mix, and it's really at the level below just routing, switching, and security. It gets down to the product lines and even within the product lines whether it's chassis and line cards and a percentage of other commodity products within our solutions.

So it's a volatile – it's a volatile product mix equation that does have propensity to go up or down a few tenths in any given quarter. We're pleased with our results in Q3. Very in line with what we expected to land, and that's really the update on gross margins..

Yeah. The only thing I'd add it, typically with the introduction of new technologies, new products, the – they introduce a tailwind to gross margin.

So the new QFX products relative to our overall switching business is in fact a positive thing, the exact same thing with routing, because what you're doing is you're leveraging Moore's Law, you're leveraging more modern silicon technology, et cetera, that tends to better optimize the cost per bit per second of your solution.

So as you think about the types of things that we're looking at to achieve our long-term gross margin goals, there's supply chain managements and costs there. There's the innovation that goes with the introduction of new technologies that are tailwinds to gross margins. Then there's just innovation.

Take, for example, some of the work that we're doing in the optical space. In particular, the recent acquisition in silicon photonics, which will have not an immediate but a long-term, I think, positive effect on gross margin. And last but not least is business model transformation.

As you think about the evolution towards more software-based business models, all of these things are factors that we believe will have a positive impact long-term on gross margins..

Got it. Thank you..

Our next question comes from Erik Suppiger with JMP Securities..

Yeah. Good afternoon.

On the QFX, can you discuss what success you're having with the cloud providers? And then how much of the QFX is shipping with 100-Gig and high-density ports?.

Sure, Erik. Well, the success we're seeing with the QFX is broader-based than just cloud. And it's broader-based than just the top cloud providers. I think that the opportunity is large and it spans across cloud providers, cable operators, telcos and large enterprises.

And we're leveraging all of our existing relationships with our customers but also of course going after net new opportunities with the QFX product line, which again I said, I believe is extremely competitive.

And in particular, where you see Juniper taking the most share is in fact in the high speed opportunities, which is over 10-Gig, 100-Gig being a perfect sweet spot for us. So if you know Juniper, you know that where we do exceptionally well is where scale and performance matters.

And where data centers require 100-Gig interfaces, typically the kinds of scale and performance they require for these data center buildouts are such that we're going to be very competitive. And that is a key area of differentiation for us today..

Thank you very much..

Our next question comes from George Notter of Jefferies..

Hi. Thanks very much, guys. I just wanted to go back to the gross margin question. You said earlier that Juniper is out to take share in switching and cloud. And I think you were referencing more the QFX initiative in that statement.

I guess I'm just wondering if I can connect to the gross margin erosion we've seen over the last handful of quarters to that initiative to take share? And then also I think last quarter you talked about some of the margin pressures really being focused in Europe. Is that still the case? Thanks..

Let me start. And I'd like Ken to weigh in. The answer to the question is no, it's not just about the QFX. Our ability to take share certainly has an element of pricing to it. But it's much more than that. Technology matters. The broader portfolio solution matters.

Things like Professional Services and our ability to go and to help our customers in evolving their networks from a legacy network to a cloud, highly automated data center with solutions like Contrail. All of these are factors. I'm not saying pricing is not a factor, but it's much more complicated than just pricing discussion.

It's not just tied to switching, and it's not only tied to Europe. I think it's broader based than that.

Right, Ken?.

Yeah. Absolutely. From a pricing perspective, specifically discounting, we did see some stabilization there this quarter as compared to last. You're right. In Q2 we did call out some elevated pricing pressure specifically in EMEA. So we're not calling out something similar this quarter.

It's more broad based but also more stable than we saw last quarter from a pricing perspective..

Got it. Great. That helps. Thanks..

Our next question comes from Rohit Chopra of Buckingham Research..

Thank you. Thanks for taking the question. Guys, I just wanted you to address Government if you could? In the commentary, it appears that it was down sequentially in Routing, Switching and Security? So I was just wondering, is that a Government issue? Or is that a Juniper issue? Thanks..

Yeah. So from a Government perspective, I'll let you talk about it a little bit, Rami, as well. But from a numbers perspective, we do see some lumpiness in the Government vertical.

It's an important vertical for us, but it's not one of our largest couple of verticals, though it does have the propensity to be up or down on a certain deployment as they happen around the world. I would make sure folks understand that Government is an international vertical for us.

So we do a fair amount of business internationally in Government sector as well. And what you saw in Q2 was actually a very strong Government number. And so sequentially we saw a little bit of a retraction but it's – we're still very focused on that vertical going forward. It's really more deployment based than anything else..

Yeah. The only thing I'll add is that it remains a key vertical for us. We're highly focused on it. The deals in the Government space tend to be larger and therefore lumpier. And we did see some push out of opportunity, I think in particular around E-Rate and other types of government opportunities. So I'm not too concerned about the Q3 performance.

I think we will see good success in that vertical going forward..

Thanks, Rami..

Yeah. Last thing I would add is we are actually up year-to-date, full year in that sector. So we're very comfortable with that sector just a quarter-to-quarter timing phenomenon..

Yeah. The only reason I asked, is it is the final – was the end of the government fiscal year. So I was thinking maybe the U.S. Fed may have seen some growth and we just didn't see it. That's what I was pointing out. Thanks..

Yeah. Yep. Appreciate the question. Thank you..

There are no further questions at this time. I'd like to turn the call back over to management for closing remarks..

Okay. Well, we'd like to thank everyone for your questions and really appreciate you restricting them to one question per firm. That was great. Thanks again. And looks like we are two hours away from the World Series kicking off, so excited about that. And we'll talk to you next quarter. Thanks. Bye-bye..

Thank you..

This concludes today's conference. Thank you for your participation. You may disconnect your lines at this time..